Fed's rate cut doesn't stop markets' fall. Will anything?

McClatchy NewspapersOctober 8, 2008 

WASHINGTON — For the second consecutive day, the Federal Reserve took bold action Wednesday in hopes of staving off a global financial collapse. And again U.S. financial markets failed to calm, extending losses for a sixth straight day while shrugging off a Fed-led, globally coordinated half-point cut in interest rates.

Under normal circumstances, rate cuts are a cause for cheer because they lower the cost of borrowing for consumers and business, spurring economic activity. But these are far from normal times, and the fear running wild on Wall Street is proving difficult to contain.

Before U.S. markets opened, and after steep stock losses in Asia and Europe, the Fed announced a coordinated half-point interest-rate cut with five other central banks. It lowered the benchmark U.S. federal funds rate to 1.5 percent, bringing down the prime rate that commercial banks charge their best customers to 4.5 percent.

Yet ignoring the very rate cut they'd been clamoring for, traders in New York began selling stocks at the opening bell, and the Dow Jones Industrial Average plunged more than 200 points within a minute of opening. It bounced back and forth between loss and gain for much of the day before closing down 189.01 points to 9258.10. The S&P 500 finished off 11.29 points to 984.94, and the Nasdaq too was down 14.55 points to 1740.33.

"Markets are manic depressive, and they're really in a depressed state right now," said Alan Blinder, a former Fed vice chairman in the 1990s, now a Princeton University economics professor. "I thought for at least one day, wrongly, that this (rate cut) would help the market psychology. It's disappointing."

Right now loan rates don't matter much because most large banks won't lend. And the interconnected web of lending across the economy has virtually ground to a halt.

So while Wednesday's Fed action may help eventually, it has very little immediate impact for ordinary Americans who are finding it difficult to borrow to purchase a home or car, or business executives seeking to finance their firms.

"We're just in a world where new debt is scarce, if not nonexistent. And this week's rate cut and the (congressional) rescue package last week are steps to try to manage the process, but they are not going to reverse it," said Ken Goldstein, a veteran economist with the Conference Board in New York. "The problem is too much debt in the financial system . . . and until those conditions change we're just staring at a world that is losing output and losing jobs."

Few economists doubt the U.S. economy is in a recession, or soon will be. The psychology of a downturn is that bad economic news creates pessimism that leads consumers to reduce their purchases and businesses to postpone investment, which weakens the economy further.

There was clear evidence of that Wednesday, when the RBC Cash Index, a survey of consumer sentiment conducted by pollster Ipsos Public Affairs, showed that American consumers are in a clearly dour mood. Almost two-thirds of the public said they feared losing their jobs, or that someone they know will, in the next six months.

"If there's the possibility of losing their jobs, they're probably not going to be spending a lot of money," said Clifford Young, a senior vice president at Ipsos.

Facing a clearly weakening economic outlook, much of what the Fed and Treasury Department are doing now is akin to plugging holes to keep the financial system afloat.

For example, on Tuesday the Fed announced it would bypass the banking system to provide emergency short-term loans to major U.S. corporations since banks won't. That ensures that corporate America can issue short-term debt to make payrolls and keep more Americans in their jobs.

The Fed has so far made available almost $800 billion in emergency short-term loans to keep the banking sector functioning.

In a speech Wednesday, Treasury Secretary Henry Paulson warned that volatile times are ahead and tried to comfort ordinary Americans, who've seen more than $2 trillion in retirement savings erased in the turbulent past year and a half.

"We are a strong and wealthy nation with the resources to address the needs we face," Paulson said, adding that by coordinating with other national governments, the global financial problems eventually will ease.

To that end, the Fed released a short statement at 7 a.m. Eastern time, saying the dramatic half-point rate cut was being taken jointly with the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Swiss National Bank and Sweden's central bank. The central banks all made half-point cuts in their interest rates.

The action came after financial markets in Asia and later Europe opened in turmoil on Wednesday. Japan's Nikkei plunged 9.3 percent — its worst day in two decades — and exchanges in Hong Kong and Taiwan dropped 8 percent and 6 percent respectively. Many European exchanges touched five-year lows as panic spread.

Fumbling for a response, Japan's Prime Minister Taro Aso told a session of parliament that the dive in stock prices "isn't normal" and was "frankly beyond our imagination."

"We have huge fears going ahead," he said.

The coordinated move by central banks was almost without precedent, and was in part a symbolic move to show that central banks were on the job together to address a global crisis.

The Bank of England on Wednesday announced that it would inject directly into several top banks upward of $350 billion to ensure that they have cash to lend. This differs in approach from the $700 billion made available to the Treasury by the U.S. Congress to purchase bad assets and get them off of bank balance sheets.

As Europe's financial problems worsened, finger pointing followed. France's finance minister, Christine Lagarde, suggested to a French radio station that the problems were caused by a U.S. decision to let investment bank Lehman Brothers collapse in September.

"What was horrendous is the decision of Henry Paulson to let Lehman Brothers go," she said, adding that "for the equilibrium of the world financial system, it was a veritable mistake."

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The Fed statement

Secretary Paulson's statement

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McClatchy Newspapers 2008

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